The 4 Most Common Reasons a Small Business Fails

Running a business is not for the faint of heart, as entrepreneurship is inherently risky. Successful business owners must possess the ability to mitigate company-specific risks while simultaneously bringing a product or service to market at a price point that meets consumer demand levels. While there are a number of small businesses in a broad range of industries that perform well and are continuously profitable, a larger portion of companies fail within the first 18 months of operation, according to the Small Business Administration (SBA). Without the proper tools in place to achieve critical business objectives, small businesses are on an inevitable path to failure.

To safeguard a new or established business from falling into the 80% of failed companies, it is necessary to understand what can lead to business failure and how each obstacle can be managed or avoided altogether. The most common reasons small businesses fail include a lack of capital or funding, retaining an inadequate management team, a faulty infrastructure or business model, and unsuccessful marketing initiatives.

Lack of Capital

Of the vast number of small businesses that fail each year, nearly half of the entrepreneurs state a lack of funding or working capital is to blame. In most instances, a business owner is intimately aware of how much money is needed to keep operations running on a day-to-day basis, including funding payroll; paying fixed and varied overhead expenses such as rent and utilities; and ensuring outside vendors are paid on time. However, owners of failing companies are less in tune with how much revenue is generated by sales of products or services. This disconnect leads to funding shortfalls that quickly put a small business out of operation.

In addition to finding funds for working capital and overhead expense needs, business owners, more often than not, miss the mark on pricing products and services. To beat out competition in highly saturated industries, companies may price a product or service far lower than similar offerings with the intent to entice new customers. While the strategy is successful in some cases, businesses that end up closing their doors are those that keep the price of a product or service too low for too long. When costs for production, marketing and delivery outweigh the revenue generated from new sales, small businesses have little choice but to close operations.

Small companies in the startup phase also face challenges in terms of obtaining financing to bring a new product to market, to fund an expansion or to pay for ongoing marketing costs. While angel investors, venture capitalists and conventional bank loans are among the myriad of funding sources available to small businesses, not every company has the revenue stream or growth trajectory needed to secure major financing from these sources. Without an influx of funding for large projects or ongoing working capital needs, small businesses are forced to close their doors.

To protect a small business from common financing hurdles, business owners should first establish a realistic budget for company operations, and be willing to provide some capital from their own coffers during the startup or expansion phase. Over time, it is imperative to research and secure financing options from multiple outlets before the funding is actually necessary. When the time comes to obtain funding, business owners should have a variety of sources to which they can ask for capital.

Inadequate Management

Another common reason small businesses fail involves the lack of business acumen held by a management team or business owner. In some instances, a business owner is the only senior level personnel within a company, especially when a business is in its first year or two of operation. While a business owner may have the skills necessary to create and sell a viable product or service, he is often lacking the attributes of a strong manager and the time required to successfully manage other employees. Without a dedicated management team, a business owner has greater potential to mismanage certain aspects of the business, whether it is finances, hiring or marketing.

Smart business owners outsource the activities they do not perform well or have little time to successfully carry through. A strong management team is one of the first additions a small business needs to make to continue operations well into the future. It is important for business owners to feel comfortable with the level of understanding each manager has regarding the business operations, its current and future employees, and the products or services the business provides.

Business Plan and Infrastructure Issues

Small businesses often overlook the importance of effective business planning prior to opening their doors. A sound business plan should include, at a minimum, a clear description of the business; current and future employee and management needs; opportunities and threats within the broader market; capital needs including projected cash flow and various budgets; marketing initiatives; and competitor analysis. Business owners who fail to address the needs of the business within a well laid-out plan before operations begin are setting their companies up for serious challenges. Similarly, a business that does not regularly review an initial business plan, or one that is not prepared to adapt to changes in the market or industry, meets potentially insurmountable obstacles throughout the course of its lifetime.

To avoid pitfalls associated with business plans, an entrepreneur should have a solid understanding of her industry and competition before starting a company. A company's specific business model and infrastructure should be established long before products or services are offered to the consuming public, and potential revenue streams should be realistically projected well in advance. Creating and maintaining a business plan is key to running a successful company for the long term.

Marketing Mishaps

Business owners often fail to prepare for the marketing needs of a company in terms of capital required, prospect reach and accurate conversion ratio projections. When companies underestimate the total cost of early marketing campaigns, it is often difficult to secure financing or redirect capital from other business departments to make up for the shortfall. Because marketing is a crucial aspect of any early-stage business, it is necessary for companies to ensure they have established realistic budgets for current and future marketing needs. Similarly, having realistic projections in terms of target audience reach and sales conversion ratios is critical to marketing campaign success. Businesses that do not understand these aspects of sound marketing strategies are more likely to fail than companies that take the time necessary to create and implement cost-effective, successful campaigns.